18-10-2014_18-18-15 / BrandtEquation-19Sept04

“that in one part of the world most people live relatively comfortably, while in another they struggle for sheer survival” (N-S, 64).

The publication of North -South caused a stir worldwide, receiving major media coverage and generating spirited discussion everywhere. It became available in more than twenty languages, including Arabic, Chinese, Swahili, and Romanian. In the early 1980s, thousands of people attended peaceful assemblies in many parts of the world in support of the Brandt proposals, early versions of today’s anti-globalization rallies. Speakers traveled the world to bring the message of the Brandt Reports into local communities. North -South was widely discussed at churches, civic organizations, conferences, universities, nongovernmental organizations, and nationa l and international agencies. More than three quarters of the world’s nations endorsed the Brandt proposals at the 35th and 36th sessions of the United Nations General Assembly.

“This Report deals with great risks,” said Brandt, “but it does not accept any kind of fatalism. It sets out to demonstrate that the mortal dangers threatening our children and grandchildren can be averted; and that we have a chance—whether we are living in the North or South, East or West—if we are determined to do so, to shape the world’s future in peace and welfare, in solidarity and dignity” (N-S, 7).

The moment was not right. Just as North-South was published, the Soviet Union invaded Afghanistan, and Western nations were suffering from a severe economic downturn. The Brandt Reports had a sustained impact on public opinion, institutional analysis, and intergovernmental diplomacy, but fear of communism and sluggish markets were of greater concern to the developed world. By 1982, the North was experiencing its worst recession since World War II, and Western leaders began to lose sight of the Brandt Commission’s views on world economic recovery and the plight of poor nations.

By 1983, when Common Crisis was published, Helmut Kohl had joined ranks with Margaret Thatcher and Ronald Reagan as leaders of the Big Three powers, stock markets were beginning to take off, and Western economies were vibrant once again. By 1985, the Brandt Reports had been brushed aside by policy makers and the public, dismissed as out of step with the times, and relegated from the desktop to the bookshelf. Developing countries were still suffering, but few seemed to care. The markets were ascendant, and the developed world was celebrating its recovery from a rocky decade.

It is instructive to look back at that period to see why the Brandt Commission was so concerned about the prospects for the North, as well as the South. Since the early 1970s, as noted, the world’s newly deregulated monetary system had a severe recessionary effect on the advanced economies. Without monetary discipline, the world lurched from crisis to crisis. Interest rates soared and growth was held back, which meant rising unemployment, lower wages, slumping currency values, and lower savings and investment. This led, in turn, to budget deficits, increased borrowing, and diminished demand in most developed economies.

Developing countries also found themselves in a desperate liquidity crunch. Petroleum exporting countries—flush with cash after the oil price increases of 1973-74—invested their money with international banks, which ‘recycled’ a major portion of the capital as loans to Latin American governments. With recession smoldering in the developed economies, commodity prices collapsed in many developing nations, protectionist tariffs thwarted exports, and aid and investment capital slowed to a trickle. Having begun to build new infrastructure around these investments, Latin nations suddenly found this money withdrawn by the big banks. It would not be the last instance of massive capital flows overwhelming the economies of small nations, with sudden swells of investment, then drastic implosions wrought by the outflow of monies.

29

“The South needs, above all, finance,” the Brandt Commission announced in North-South. “Most rich countries have accepted the target of giving 0.7 per cent of their GNP in the form of official development assistance, but few have lived up to it. Most aid goes to finance the foreign exchange costs of projects, but many of the poorer countries also need support for local expenditures and for imports of non-capital goods. Some of the more prosperous countries in the South have recently borrowed extensively from commercial banks, causing heavy problems in rolling over their loans, which by the end of the 1970s were causing anxiety to borrowers and lenders alike. And many developing countries will need much more finance over the next twenty years to produce any real improvement in health and nutrition, in mineral and industrial development, or in sustaining satisfactory growth” (N-S, 43).

Mexico nearly defaulted in August, 1982. Private international banks in New York City, which held the bulk of Mexican loans, were panic stricken. A financial rescue package for Mexico was cobbled together by the US and other G-7 Central Banks through the IMF and the World Bank. As other developing nations struggled to pay the interest on their loans, the big banks had to reschedule the debt and reduce additional lending for them as well. By forcing developing countries to maintain their interest payments, a major banking collapse was averted; but growth rates fell, and a debt crisis spread through Latin America, rippling across the world to Asia and Africa.

This government-sponsored bailout of the private banks was a turning point. Mexico had been saved and a possible world economic collapse averted. More significantly, a new practice had been successfully tested: private debt was converted into public liquidity at the international level. In the Mexican bailout, national public assets underwrote international capital ventures with virtually no accountability. Taxpayers in the G-7 nations were not even aware they were footing the bill. It was the first step in a new global approach: unofficial financial guarantees through the internationa l system by developed nations, offering government subsidies for private investment in developing nations.

To receive their new loans, debtor nations in Latin America had to agree to certain conditions. They were required to reduce government programs, slash investments, and run trade surpluses to repay the interest. In many cases, nations were also required to devalue their currencies. These measures were supposed to increase the prosperity of the developing economies, but the new loans were not channeled into productive investment or antipoverty programs. They were used instead to pay the interest on existing loans.

Depression lingered in Latin America from 1981-1986, but it took the US stock market crash of 1987 to jolt developed nations back to economic reality. There was a new sensitivity on the part of officials that developing country debt was a serious matter and required new solutions. What would happen, after all, if a major default in the Third World were to coincide with a stock market crash?

In Common Crisis, the Brandt Commission warned of a global economic crisis resulting from the unpaid debt of developing nations. Brandt called for external financial support from banks and international agencies, and debt relief to ease the balance of payments problems. The Commission envisioned a new framework for development finance, including increased aid, greater lending through international financial institutions, massive resource transfers to developing nations, and a new World Development Fund. Brandt’s panel also proposed that revenues be gained from use of the global commons—the oceans and the sea-bed—as well as international taxes and levies on arms trade.

“Our situation is unique,” Brandt exclaimed. “Never before was the survival of mankind itself at stake; and never before was mankind capable of destroying itself, not only as the possible outcome of a worldwide arms race, but as a result of uncontrolled exploitation and destruction of global resources as well. We may be arming ourselves to death without actually going to war—by strangling our economies and refusing to invest in the future. Everybody knows—or should know—where the world economic crisis of

30

the 1930s ended. Everybody should know what immense dangers the present international crisis holds, and that only a new relationship between industrialized countries and developing countries can help overcome this crisis” (CC, 9).

Two decades later, the problem remains: how to ensure a steady flow of capital to poor nations without the heightened risks that force investors to pull back sharply, causing developing economies to implode. Common Crisis asked the developed world to increase investment in the developing world, but under the terms of a stable, globally managed economy. That, of course, is not what happened. While international banks were too skittish to reinvest in developing nations as they had in the late 1970s and early 80s, there emerged a new source of development finance.

Foreign Investment and the Second Debt Crisis: Southeast Asia

The post-modern economy is largely a history of the unfettering of the market by means of floating currencies, open financial markets, and lower trade barriers. World monetary deregulation in 1971 was followed by financial deregulation in the 80s, and trade deregulation in the 90s.

With the lifting of capital controls and ceilings for interest rates during the Reagan-Thatcher-Kohl years, finance capital was free to flow across borders, seeking the highest rates of interest. Under the United States’ Brady plan in 1989, the Latin debts held by major commercial banks were converted into bonds. International banks held some of these bonds; others were offered to the public through insurance companies, mutual funds, and pension funds. These new financial products were designed to prevent the exclusive exposure of banks to debt crises in developing nations by spreading the risk of global investment.

With the lifting of trade barriers during the Clinton-Major-Kohl years, developing countries increased exports and earnings. However, with their massive debt loads, even these increases in foreign exchange accumulation and domestic savings could not generate significant economic growth, leaving poor nations all the more dependent on foreign capital. As each developing nation embraced free market capitalism, it was absorbed more deeply into the global financial market. Developed nations, led by American investors increasingly eager to diversify their financial holdings, poured billions of dollars into overseas debt and equity markets.

Foreign securities trading exploded. Almost overnight, investment prospects in emerging economies were upgraded from non-creditworthy to red-hot. Once-risky developing nations suddenly became exotic ‘emerging economies’. In spite of minimal banking and legal safeguards in many poor countries, and the near-default on Mexican sovereign debt in 1994, total portfolio investment in developing nations increased to $94 billion. From derivatives and options, commodities and futures contracts, to currencies, stocks, and bonds—financial instruments were all the rage in the 90s, and no place on earth seemed beyond consideration for investment.

Meanwhile, through foreign direct investment, large American, European, and Japanese companies could now become owners in the utilities, the energy plants, and the industrial factories of a developing country, not just its stocks and bonds. As a result, corporate objectives broadened. In the early 1980s, international corporations invested in developing countries to manufacture and market goods locally. By 2000, the situation had shifted: foreign companies were investing in developing countries to produce and sell goods globally.

From 1980 to 2000, foreign exchange trading and foreign corporate investment both increased fivefold. Developing nations became, in effect, capital sinks for the world’s investment houses, and export platforms for the multinational corporations. With all the new overseas investment by financial

31

institutions and corporations, and the new jobs and wage increases that resulted, many developing economies experienced a recovery for the first time in more than a decade. Investment in foreign assets and factories in the 90s seemed to fill the vacuum created by the collapse of bank lending in the 80s.

As the new century dawned, half of all American households, whether by direct or institutional investment, were stockholders in corporate enterprises, many with overseas holdings. Stocks accounted for 1/3 of total personal wealth in the United States. The number of European and Japanese investors also increased rapidly during the 90s. Through direct stock ownership or through institutional investment— insurance companies, pension funds, mutual funds, and hedge funds with large investments abroad— millions of Westerners became owners of stocks in developing countries.

The enthusiasm suddenly turned dark in 1997 as trouble spread in South Asia. When they spotted a currency depreciation looming in Thailand, emerging market investors cut their losses with the push of a button to bring their funds safely home. The shakeout wasn’t confined to the devaluation of the Thai bhat. Suspicious of similar weaknesses in the region—shaky banks, indebted corporations, overvalued currencies, large budget deficits, inflated stock and property values, and weak legal protection—finance houses also trimmed holdings from neighboring countries to pay back nervous shareholders, draining the treasuries of several nations.

In 1997-98, devaluation, followed by raging inf lation, spread from Thailand to South Korea, Indonesia, Malaysia, and then to Russia and Brazil. The sell-out of the emerging economies in Asia produced not just soaring interest rates, but currency collapses in the Philippines, Malaysia, Taiwan, Indonesia , and South Korea. Capital dried up. Workers were let go. Stock prices collapsed all over Southeast Asia. World trade slowed. The IMF was called in to revitalize the comatose economies. These rescues involved some $230 billion in relief packages for Mexico, Thailand, Indonesia, South Korea, Russia and Brazil.

Rampaging international capital flows had struck, wreaking havoc again. Like the black hole created by the collapse of bank lending in the 80s, the flight of investor capital in the late 90s created a massive shortage of money in emerging economies. In 1999, they began to bounce back, but slowing global growth dashed initial hopes of recovery. South Korea, Russia and Mexico have revitalized, but Latin America is still experiencing weak exports, deteriorating terms of trade, and decreasing capital flows. Industrial production in Southeast Asia has also fallen off sharply, especially in high technology, because its major export customer—the US—is undergoing its own slump in consumer demand.

Japan has been experiencing severe recession and deflation for more than a decade. China’s entry into the World Trade Organization in 2001 has forced it to restructure its banks and corporations, lower import tariffs, drop prices, and lay off workers, creating deflation both at home and elsewhere in Asia. At the same time, there is deep instability in Asian banking sectors. Japan and China both have large levels of non-performing loans. At the end of 2001, Southeast Asian nations also had more than $2 trillion in proble m loans—30% of their GDP. International banks continue to suffer losses in these countries because of delayed loan payments, as well as outstanding loans to hedge funds which lost heavily in the panic of 1997-98. Crippled by debt and perceived as investment risks, developing nations continue to experience the effects of a shortfall in liquidity.

The global situation now is more complex and more serious than two decades ago. In the Latin crisis, government debt threatened to bring down the international banks. In the Asian crisis, the debt owed to companies and banks threatened the world’s stock markets, endangering millions of investors, large and small. In a third debt crisis, international banks, private investment houses, and the world’s stock investors may all be exposed.

32

When financial markets are so closely fused, an economic malady in one nation can spread through the global neighborhood overnight, leaving devaluation and default in its wake. It is unlikely that the safety nets of the G-7 and IMF would be able to weather a major global credit collapse, due to the escalating level of debt saturation across all sectors of the developed world—household, corporate, and government. Financial instability affecting the unregulated derivatives market, now at $130 trillion, would also absorb major capital sources needed for global crisis intervention.

At the same time, there is no international framework for foreign exchange trading or foreign direct investment to spread the risk between debtors and creditors, and stabilize financial conditions in developing economies when foreign investors suffer losses from failed loans. After two major debt crises in twenty years, no source of public or private financial assurance appears willing or able to step up again to a new challenge. Next time a currency crisis hits, there may be no economic guarantor large enough to bail out the stricken nations.

Crisis Finance: Who Wants to be a Lender of Last Resort?

By late 1998, the near-meltdown of the international financial structure had rattled the leaders of the free world. When the G-7 finance ministers met to discuss the risks of unbridled capital flows and the possibility of a new ‘financial architecture’, it reminded many observers of an earlier discussion on reforming the global financial system.

At the urging of the Brandt Commission in North-South, an economic summit of leaders from developed and developing nations convened in Cancun in late 1981. As noted in the section on Global Negotiations, the International Meeting on Cooperation and Development was the first, and only, meeting of its kind.

National leaders discussed international development issues, but the conference lasted just two days and no action or follow-up was initiated. To keep the momentum going, the Brandt Commission issued a second report in 1983, Common Crisis, which proposed expanding the role and resources of the IMF and World Bank, and creating a new framework for international finance and trade. Common Crisis also urged the community of nations to ensure greater bank supervision and regulation in developing countries, while requiring more accountability from international financial institutions.

What is needed, said the Brandt Commission, is a global institution charged with balancing the private sector with the public interest, to mitigate shortfalls in development finance and ensure orderly and sustainable growth. Brandt’s early version of this idea was twofold: the creation of a World Development Fund and a Development Advisory Body.

At present, most aid to developing nations is simply an extension of credits that developed countries use to promote the export and purchase of their capital goods. This gives poor nations an ability to pay for imported goods, but not to generate additiona l capital. A sustainable source of external financing is needed to ensure that local currency expenditures are not soaked up by inflation and balance-of-payments shortfalls. This source of development finance could come from a variety of untapped ‘universal’ sources, including fees on international corporations, international airline tickets, maritime transport, ocean fishing, satellite parking spaces, electromagnetic spectrum use, arms trafficking, environmental pollution, foreign currency trades, hedge funds, and derivatives.

As a start in this direction, the Brandt Commission proposed a “World Development Fund—with universal membership, and in which decision-making is more evenly shared between lenders and borrowers, to supplement existing institutions and diversify lending policies and practices. The World Development Fund would seek to satisfy the unmet needs in the financing structure, in particular that of program lending. Ultimately it could serve as a channel for such resources as may be raised on an universal and automatic basis” (N-S, 255).

33

In addition, the Brandt Commission saw the need for a high-level body to monitor and coordinate international development. The Development Advisory Body would be a small ‘brain trust’, an independent group without executive status. It would monitor and evaluate the work of the different international agencies in the field of development, and report on their effectiveness to governments and the UN General Assembly and its organs. Its aim would be to “streamline the institutions, to define their objectives more clearly, and to achieve them more economically and effectively.” It would be “a body of 12 members: a third of the members would be citizens of developing countries, a third would be from the industrialized countries and the remaining third selected for their experience and independent judgment” (N-S, 261). They would also report to the public and be open to public input.

Nothing came of these ideas in the 1980s. In 1989, Willy Brandt asked Ingvar Carlsson and Sir Shridath Ramphal to convene an Independent Commission on Global Governance. After Brandt died in 1992, the new Commission deliberated and issued a 1995 report, Our Global Neighborhood. The Global Governance Commission expanded the idea of a Development Advisory Body, calling for a new international group to manage economic interdependence. This new international financial body needn’t be a large bureaucracy but a small council, making it more representative and flexible than the World Bank or the International Monetary Fund. This new council, which some have likened to a Global Economic Ministry, could provide oversight and advice on the international coordination of policies, specifically to:

∙monitor the state of the international economy

∙anticipate monetary and financial crises

∙track currency exchange rate stability

∙take the risk out of international financial flows

∙provide a long-term policy framework for sustainable development

∙secure consistency between the major international organizations

∙register input from regional organizations

∙build consensus between governments on new global economic policies

This type of coordination for the international economy is still lacking. A new democratic international structure, representing the interests of all people, would face many complex issues. Regulation—tighter controls on currency movements—is especially needed in international investing. Fair competitive practices must be ensured and monopolies restricted at the global level. At the same time, global financial institutions and corporations must be made more accountable to the public interest. Global safeguards are also required to prevent capital flight, fraud, money laundering, insider trading, and gridlock in financial markets. Without a responsible world authority to oversee speculative money trading, all nations, and developing economies especially, are at the mercy of erratic changes in capital flows, interest and exchange rates, and inflation.

The flexible exchange rate system, the world’s economic ‘non-policy’, has been in effect for more than thirty years. To cope with cyclical swings in international capital flows under this arrangement, developing nations have adopted surrogate means of stabilizing their currencies to prevent financia l panic. Some nations ‘dollarize’—that is, they use actual US dollars for their currency. Other nations maintain a fixed exchange rate by linking their currency at parity with a strong foreign economic unit, usually American dollars. Still others prefer capital controls—a strict ban on currency trading during economic crises.

None of these are permanent solutions, simply ways of avoiding the volatility that plagues free-floating currencies in a disorderly international system. Without a sovereign economic guarantor at the global level, the US Federal Reserve assumes the unofficial role of arbiter of global interest rates and currency

34

values. Staking a nation’s economic future to the strength of the US dollar and the monetary decisions of the US Central Bank has been a mixed blessing. Surrogate measures to ensure predictable exchange rates—dollarization and currency pegs—have had encouraging results in countries such as Ecuador, but have been disastrous in places like Argentina.

The lack of global oversight is even more troublesome now than in 1983, when Brandt warned, “The international community has made little headway in tackling its most serious problems which begin in the strained system of international economic relations and result in additional burdens on many developing countries. Prospects for the future are alarming. Increased global uncertainties have reduced expectations of economic growth even more, and the problem of managing the international imbalances of payments is increasing the threat of grave crises in international finance. We have serious doubts as to whether the existing world machinery can cope with these imbalances and the management of world liquidity and debt” (CC, 2).

These concerns loom larger than ever. What happens when a country’s foreign currency reserves are less than the amount due on its debts? Who does a country turn to when it is broke? Nations that cannot derive their liquidity from private markets seek relief from the world’s lender of last resort, the International Monetary Fund.

In return for a loan from the IMF, a poor country agrees to a series of conditions. When the Fund insists that a debtor nation raise interest rates, cut spending, raise taxes, and protect its currency—sometimes through devaluation—these measures often make the local situation worse. Property values slump, industrial production suffers, national reserves are depleted, and state assets are sold. In many cases, IMF austerity measures have resulted in deep recession, declining living standards, civil unrest, and even the fall of governments, as occurred in Argentina in late 2001. It’s no secret that IMF conditionality serves the G-7’s foreign policy interests over the interests of poor people in indebted nations. IMF restrictions are basically an attempt to restore the trust and confidence of the global market by demonstrating that a defaulting borrower is compliant and willing to cooperate with the global monetary and financial machinery, making it more attractive to international investors.

A practice known as ‘moral hazard’ was behind the multibillion dollar rescue operations of the 1990s. As a global financial rescue authority, the G-7 made it easy for risk-taking banks and high-stakes financial institutions to get paid off with public monies when their investments in emerging economies ran into trouble. In each debt liquidation, IMF money simply passed through the hands of the debtor countries on its way to the creditors. These creditors—the international banks and brokerage houses—were the same ones that had rushed to make speculative investments in the first place, then pulled their money out, leaving behind impoverished and ruined economies.

Under this arrangement, lending and borrowing nations both end up losing. On one hand, when taxpayers from the Group of Seven nations pay for IMF bailouts, it creates more debt for their governments. On the other hand, the loans to developing nations are for debt repayment only, not targeted for domestic development, ensuring that the local cycle of borrowing, debt, and poverty is perpetuated. The sole beneficiaries of these mega-bailouts are the international banks and security houses, which are, in effect, extracting revenue from the boom and bust cycles of poor nations.

The IMF has been searching for a different way to aid indebted nations without rescuing private creditors. In 1999, the Fund offered pre-approved credit lines to developing nations that promise to follow strict economic and social policies to shield them from investor panic. The program never got off the ground. Developing nations would not agree to these new loan offers, since to accept the new credit line might send a signal to foreign investors that the recipient nation had underlying economic weaknesses.

35

To provide some order to the messy business of sovereign default and avoid scaring investors away from emerging markets, the IMF announced in late 2001 that it was creating a new framework for the resolution of debt crises between creditors and debtors. The new restructuring plan would be similar to US bankruptcy law. In return for promising to adopt new fiscal policies to prevent future debt crises, developing nations would be afforded legal protection from private creditors. Rather than a judgment imposed on a defaulting borrower by lenders, there would be a negotiated settlement for debt restructuring. The way it is outlined, however, this plan would entail a major conflict of interest for the IMF. As the bankruptcy arbiter, major financial creditor, and principal economic advisor for a defaulting nation brought before the global debtor’s court, the IMF is proposing to play the roles of judge, prosecuting attorney, and star witness—hardly a fair or objective situation.

Since the Cancun Summit in 1981, the G-7 nations have strongly opposed changes to the existing superstructure of international finance. Now, those nations are discussing global reforms. After the debacle in Asia and Russia, the G-7 began to push for better corporate accounting, more bank supervision, increased access to offshore banking, and new regulation of hedge funds. The G-7 also explored the possibility of creating a fund to underwrite the risk of the financial industry in making investments in emerging markets. Private insurance would be guaranteed before foreign investments are made, rather than after they turn bad. In the case of default, creditors could collect their money directly, without having to go through the IMF.

In April 2002, at the urging of the United States Treasury Department, the G-7 nations took this idea further, proposing that markets could resolve cases of sovereign debt default without a private or public backup fund. Borrowing nations would simply agree to contingency clauses in their bond contracts with investors that would guarantee orderly debt repayment procedures. With the steps for payments stoppage, restructuring, and arbitration clearly spelled out in advance, the process of sovereign default would be far less chaotic.

The G-7 plan has some major flaws, however. While the new arrangement would increase the investment certainty for creditors, it is likely to produce greater uncertainty for borrowers. Developing countries have already expressed the fear that these debt restructuring clauses would indicate to the world market that their economies have been flagged as special risks, which would encourage higher interest rates on new bonds and discourage the very foreign investment that the contingency plan was intended to attract. In addition, these restructuring clauses would apply only to new debt issues, not to existing debt, which would still be subject to fractious resolution with creditors in case of default. Finally, the clauses would contain no provisions for the additional aid that would obviously be required to help a defaulting nation pay off its contingency agreement.

Though many would like the private sector to take a pro-active part in debt crisis resolution, financial institutions themselves have balked. Since the Russian monetary crisis, the emphasis in financial circles has been on risk management. Bankers and fund managers are all checking and rechecking their exposure and protective ‘firewalls’ against monetary and political risk in developing nations. Financial institutions have expressed little willingness to act as a lender of last resort or insure their risks in emerging markets as long as those economies lack the economic and legal infrastructure to protect overseas investments.

Another proposal is to link repayments on loans to commodity prices. This has the virtue of spreading the risk of default between borrowers and lenders. That would be a positive development. On one hand, as the Brandt Reports noted, “more stable prices would be beneficial to exporting countries by helping to maintain foreign exchange earnings and to facilitate fiscal planning and economic management” (N-S, 148). On the other hand, involvement of lenders in these commodity price stabilization measures would add greater responsibility to their lending practices.

36

An updated version of the Common Fund, proposed by the Brandt Commission, would be useful in this regard. It would be a pool of money that would finance stocks and other investments to help the production, processing, and marketing of commodities. The Common Fund would support international commodity agreements, and provide coordinated financing of commodity development policies related to market stabilization. Guaranteed by banks and financial institutions, this fund could provide a buffer for commerce and trade during the next national or regional economic meltdown.

In the Latin debt crisis, international banks held the debts of developing countries and paid the bulk of the bill. In the Asian debt crisis, the debts were held by the banks, along with insurance companies, mutual funds, and pension funds held by millions of investors; the bailouts consisted mostly of G-7 public funds. Today, the world economy remains vulnerable in several areas:

∙the banking and public debt crisis in deflationary Japan

∙the inability of Malaysia, Singapore, Hong Kong, and most of Southeast Asia to recover from recession

∙the deflationary slump in China

∙the struggle with recession in Germany and the rest of Europe

∙the currency devaluation in Argentina

∙the trade deficit, debt burden, and recession in the United States

This is the short list of trouble spots. Deflation and currency devaluation in these or other regional flashpoints could set off another round of financial contagion, triggering a vicious round of panic and capital flight across the world. In a third debt crisis, the size of the rescue operation required would be enormous, especially if rich nations join poor ones among the victims.

For the last twenty years, there was always one economy in the world strong enough to save the others from recession by buying their products. After the international bailouts of 1997-98, the US acted as the global consumer of last resort, lifting the world from an economic downturn. History is not likely to repeat itself. American consumers continue to borrow and spend, but not vigorously, due to their low rate of saving and mounting job losses. Consumer spending and business investment are also down across the world. Growth rates in world trade are at their lowest in two decades, increasing just 1% in 2001, down from a 12% increase in 2000.

Because it imports far more than it exports, America borrows more than $1.5 billion a day from abroad to cover the difference. The US foreign trade gap—and the current account deficit that sustains it—pose a real danger to the world economy. A sudden shift in real exchange rates could cause foreign investors to pull their money out of the US in search of higher returns elsewhere, triggering a chain of events: a drop in the value of the dollar, a plunge in the American stock market, a rise in interest rates, and a slowdown in US economic growth, which would have adverse effects across the globe.

Each major economic region—the United States, Europe, and Japan—is in or near recession. Asia, Latin America, the Middle East, and Afric a, which are heavily leveraged on the growth of the rich nations, are struggling with recessionary conditions. Though foreign corporations have increasing access to China’s 1.3 billion consumers, Chinese purchasing power is relatively flat due to foreign competition and government restrictions on domestic trade and investment.

It is evident that the IMF and G-7 cannot continue to insure the capital that surges into and out of developing countries from the finance houses and banks of developed nations. After the Clinton era of ‘moral hazard’, there is a new attitude that capital lenders must assume full risk for their investments in developing nations, though it is unclear the extent to which the Bush administration will resist IMF

37

intervention in major cases of sovereign debt default. Knowing that public emergency aid packages are less likely to be available, foreign investment banks vied with bondholders and fund managers for the most favorable terms on investment losses in the 2002 restructuring of $141 billion sovereign debt in Argentina, even as the IMF insisted that it be paid off before any private creditors.

Should this set a precedent, a higher volume of investment monies than public monies may be lost in the next major international currency crisis, leaving millions of insurance company, hedge fund, mutual fund, and pension fund investors vulnerable. The wider threat is that a debt default like that in Argentina may not be contained to a single nation, leading to a major rolling selloff by investors around the world and encouraging more countries to default on their loans. Just as serious, the populist backlash and political instability which many nations experience during a domestic economic crisis can also make foreign investment in these countries far less attractive.

In 2002, the Bush Administration proposed a new system of credit ratings through which developing nations may qualify for access to private markets. The strategy is that by imposing a sovereign debt standard upon new borrowers, providing markets an immediate indication of their credit-worthiness, developing nations would gradually decrease their dependence on international aid and increase economic growth. Proponents of this idea maintain that establishing credit ratings on debt would force the governments of poor nations to create more disciplined financial structures, balance their budgets, ensure greater political transparency, create stronger legal systems, and increase the protection of property rights in order to win new investments from the private sector. ‘Good economics’ and ‘good governance’ would thus eliminate the need for a global financial safety net.

The problem with this proposal is that market standards for sovereign credit quality would favor a handful of developing nations over others. As foreign investors avoid the ‘junk-grade’ government debt issues of the poorest nations, only the wealthier developing nations would qualify for the new high-grade investment. Developing nations that do not score well on these development criteria will have to scramble for alternative sources of finance, if available, gradually widening the divide between the wealthier developing nations and the less developed.

The Bush proposal is, in effect, an attempt to deregulate the sovereign le nding market. Ratings on the debt payment capabilities of developing nations would certainly reduce the risk for investors, but would also have a chilling effect on financial liquidity in developing nations too poor to qualify for new loans and investment. It seems ironic that the G-7 nations—led by the United States—are now blaming the World Bank and International Monetary Fund for forty years of failure in achieving the economic and political reforms necessary to reduce poverty in developing nations, without mentioning the role that private investment has played in increasing foreign ownership of government services and local safety nets, leaving poor nations vulnerable to unregulated speculation, recession, and macroeconomic shocks. While the G-7 calls – justifiably – for greater transparency and accountability on the part of the international public lending institutions, G-7 nations are still opposed to governmental or regulatory oversight of the vast private foreign exchange and investment markets. Even within their own countries, national regulators have scant information about global markets and the activities of international financial firms, and there is no global agreement as to what would constitute adequate national - let alone internationalstandards for economic and financial regulation.

This broad lack of regulation encourages investment capital to focus on financial diversification, rather than local economic development or global investment safeguards for emerging economies. The problem is the same as it was in 1980: how to get cautious investors to absorb their failed loans, without strangling the foreign capital needed for continued development in poor countries. A new regulatory framework for foreign investment and global financial management is needed. It is hardly surprising that governments, central banks, private banks, private creditors, and the IMF are all reluctant to take responsibility for

38